Fixing the Public Sector Pension Problem

February 18, 2013

Many states are facing daunting fiscal deficits. These take the form of unfunded liabilities totaling almost $1.4 trillion, stemming from obligations to pay for public employees' pensions, retiree medical insurance and other retirement benefits. Reform efforts ostensibly being made to solve this crisis have fallen short, says Richard C. Dreyfuss, a senior fellow with the Manhattan Institute.

These "reforms" include:

  • Issuing new bonds to refinance existing liabilities. But these merely add to the total sum of indebtedness, and the capital they raise is subject to raids serving other purposes.
  • Adopting new or modified defined-benefit plans that create new risks for current and future taxpayers. Optimistic investment-return assumptions further mask the true magnitude of these deficits.
  • Assigning existing unfunded liabilities to younger, more recently hired workers, whose own benefits will likely prove unsustainable as their salaries rise.
  • Early retirement incentive plans. But these often turn out to be expensive, hampering productivity while not achieving long-term objectives.

The necessity for real reform is problematic for policymakers, who must deal with a workforce resistant to the loss of guaranteed monthly pension benefits; and for political constituencies, including government workers and their allies, whose support for defined-benefit pensions in the public sector stems as much from ideology as from financial self-interest. This is a balancing act that leaves policymakers with few politically popular choices. Yet politicians' current approach to evading such opposition -- that of adopting incremental reforms while repeatedly deferring liabilities -- is no longer viable.

While governments confront very steep legal obstacles to extricating themselves from obligations already incurred, they should take a page from the private sector and shift to defined contribution plans. Under such plans, to which employees as well as employers may contribute, investment risk is borne by plan members, not by taxpayers. A majority of Fortune 100 companies have already adopted such plans. Only 16 percent of large companies still offer their retirees medical coverage.

By sharing risks with the beneficiaries, states and municipalities would be able to devote far more of their time and resources to the more immediate concerns of today's voters and taxpayers.

Source: Richard C. Dreyfuss, "Fixing the Public Sector Pension Problem: The (True) Path to Long-Term Reform," Manhattan Institute, February 2013.

 

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